Sec. 179 Expensing Election

By now, most advisers are familiar with the 30% additional first-year depreciation rule for qualified assets placed in service after Sept. 10, 2001. Advisers try to keep clients up to date on complicated tax law issues, especially potential tax savings ideas. Telling a client about the new depreciation is informative, but beyond identifying qualified property, advisers cannot offer much more. However, real value still comes from making the most out of the Sec. 179 expensing election.

Basically, Sec. 179 allows clients to elect to expense up to $24,000 of certain property used in their trades or businesses and placed in service in 2002. But clients have to meet eligibility rules, and that is where tax advisers can be of assistance.

Playing by the Rules

Dollar limit. After 2002, the dollar limit increases to $25,000. The strategy is to select assets that maximize the current-year’s Sec. 179 deduction. If a taxpayer acquired assets with different recovery periods, the assets with the longest useful lives should be selected first. Also, if the mid-quarter convention is an issue, taxpayers can select assets acquired in the last quarter of the tax year. (Property expensed under Sec. 179 is not includible in the 40% mid-quarter test.) On the other hand, rare situations exist in which the mid-quarter convention can produce higher depreciation—when the taxpayer acquires significant assets in the first half of the year. Finally, if assets not qualifying for the 30% additional first-year depreciation qualify for Sec. 179 (e.g., used equipment), the taxpayer should select these assets first for Sec. 179 purposes, to maximize the assets qualifying for the depreciation rules.

$200,000 rule. This rule requires a dollar-for-dollar reduction in the dollar limit for asset acquisitions above $200,000. Thus, the entire Sec. 179 deduction would be lost if total acquisitions of qualified property were $224,000 in 2002. The key is to avoid including nonqualified property in total acquisitions for Sec. 179 purposes. For example, real estate, intangibles or property acquired in a tax-free exchange should not be included, nor should carryover basis in a like-kind exchange (except the portion of the replacement property purchased with cash). Finally, if property was acquired at year’s end, it actually must be placed in service by year’s end to qualify. Under Sec. 179(b), the dollar limit is reduced only for property actually placed in service.

Taxable income limit. This rule limits the Sec. 179 deduction to a taxpayer’s taxable income from all trades or businesses. Nondeductible Sec. 179 amounts should be carried forward for a deduction in later years. Note: For individual taxpayers, the limit applies to aggregate taxable income from all trades or businesses. Thus, if one business has income, but another a loss, the deduction would be available if combining the two produces income. Also excludible when calculating the taxable income limit are the Sec. 179 deduction, net operating loss carrybacks or carryforwards and the Sec. 164(f) deduction for one half of self-employment tax.

Conclusion

For S corporations and partnerships, the rules apply at both the entity and shareholder/partner levels. In computing the taxable income limit for an S corporation for purposes of the Sec. 179 taxable income limit, the compensation paid to shareholder-employees should be added back to regular taxable income.

The roadblocks can be easily overcome by advisers. Small businesses can benefit from substantial tax savings through Sec. 179 deductions. An analysis and mindful selection of the property to expense can maximize the deduction.

From Frank E. Brodnax, CPA, Ellin & Tucker, Chartered, Baltimore, MD